Morris and Morris (2007) in the Standard & Poor’s dictionary of financial terms have defined an emergency fund as one intended to endow with economic support for unanticipated expenses or for a time when one is not in gainful employment yet requires an income. Given that in life every individual goes through life cycles – one day one is up while the next they are down, it is important that one sets aside some finances to use when they are down until they can rise again.
As such an emergency fund is not one which an individual dips in to meet recurrent expenditures; rather it is only used when one has to meet non-recurrent expenditures that cannot be met within the premise of the recurrent expenditure budget like death (Folgate, 2010). It will, however, be used to meet recurrent expenditures where the saver finds him/herself without a regular source of income, while they seek another regular source of income.
In the prevailing economic conditions, the creation of individual emergency funds and by extension embedding a saving culture in individuals can greatly be natured by the federal government put in place policies that encourage this. At the end of the day, the federal government will be better off if its population is one that aggressively pursues a saving function. The federal government will thus find itself using fewer funds to provide a soft landing to individuals and stimulate the economy. Similarly, by the population being able to spend and thus consume produced goods, the economy will be able to get out of the current crisis faster than if individuals had no emergency funds and thus depended on the government for their basic consumption.
Why set an emergency fund
There is Aesop’s fable of the Ant and the Grasshopper which best captures the importance of building an emergency fund. According to the fable, the Grasshopper kept mocking the hard-working Ant for wasting a beautiful summer hustling tirelessly storing food for the winter. Of course, the warm summer sunshine rays gave way to the colder northern winds. As the grasshopper gets stuck out in the cold with nothing to eat, the ant is happily feeding his face in his warm ant hill.
The lesson from the fable is that if one does not prepare when things are good when the hard times set in they will be sorry like the grasshopper was. Great care should be taken in understanding the lesson herein. It does not mean one cannot have fun, rather that if one wants to have fun in the future, then they had better get their investment objectives straight now. Just because one is currently hard-pressed by immediate needs – paying college fees, raising kids, getting married or buying a house, does not mean one cannot work on their retirement fund. It is a wise person who will find a way to meet all the current financial needs while keeping a nest for a rainy day (Koch & Johnson, 2009).
There are many ways that an individual builds a nest for a rainy day. It should be clear that keeping away some finances for a rainy day should not be the preserve of individuals with a regular income, but even those with intermittent incomes. In an actual sense, individuals with intermittent incomes need to have an emergency fund more than those with a regular income. Having an emergency fund is not only critical but for an individual to survive and enjoy making money it is an aspect they have to wholly and embrace (Lankford, 2003).
Strategies applicable to an individual of setting up an emergency fund
In reality, an emergency fund will be critical, in an individual’s effort to stop getting into debt – by having an emergency fund one need not use credit cards to meet emergencies thus reducing falling deeper into the debt hole, in smoothing out an individual’s budget – when emergencies crop up one need not re-factor their budgets, but can comfortably meet these needs while keeping within their budget, for individuals living from pay-check to pay-check – there comes times when some bills will be late or when one has to overdraw their account, however with an emergency fund one can easily avoid this financial hits, and finally, with time one can totally eradicate financial stress by avoiding playing catch-up to bills and instead pay them in advance (Taylor, 2010). This way one can sit back and relax and enjoy making and spending money.
To achieve this, an individual has to make a concerted effort and embrace savings as an integral component of their life. This is not an easy undertaking to wholly embrace; however, there are some strategies that when incorporated into one’s life will greatly contribute to one achieving the goal of creating an emergency fund.
Irrespective of how much one earns, one must save. Thus, one should start small. It is important to remember that that which looks small at the beginning will over time turn out to be pretty substantial (Folgate, 2010). Starting small is very important since it steadily natures a saving habit in an individual. When finances increase, an individual with an inbuilt saving habit will find it easy to save more than one who waited until they had more money.
The temptation to use money the moment it is in one’s hands is normally very high. One can circumvent this by giving instructions to their bank to deduct a certain specific sum which is then directly deposited into a saving account. This way one does not at any given time come into contact with the money to be saved for the emergency fund. Thus, one does not have to think about it and can thus fit their lifestyle into what remains.
In line with having a standing order with one’s bankers, one can also request the employer to deduct a certain figure from their salaries before it gets to their bank account. This is a strategy that is ideal for individuals who appreciate the need for financial discipline and who know they have a glaring shortfall in this department. When this is done, one avoids the temptation of having to withdraw all the money from the account before the standing order is enforced thus defeating the savings strategy.
One could also reduce an expense equivalent to the desired emergency fund savings and save on it. This way one can cut down on some expenses that can be considered not critical and use the money saved to create an emergency fund. One could also look to cut back on a variety and wide range of expenses without necessarily totally cutting out a particular expense.
One could also seek to kill two birds with the same stone. This is possible by having any amount in the savings account above the desired monthly target being used to pay off an outstanding debt. This could be referred to as the double purpose account. By setting a monthly target for saving to the emergency fund, any additional monies above the target in the account will be used to pay off a debt. This way one can achieve debt reductions while creating an emergency fund concurrently – killing two birds with the same stone (Elle, 2010).
One can also use normal occurrences to create an emergency fund. When one dines out or receives a service, it is normal to tip a waiter or service deliverer. One can thus choose to tip oneself the equivalent of what they tip others. This way one can create an emergency fund from these tips which will go directly to savings (Lagace, 2008).
Another strategy one can employ to create an emergency fund is turning oneself to be one’s, own debtor. When one has paid off a debt that had been factored into an individual’s monthly budget one could keep the debt deduction in the budget and instead use the money to pay themselves and thus use this money to create an emergency fund. The advantage with this strategy especially if the debt had been a long-term one is that one does not experience a change in lifestyle nor feel any extra burden of savings (Caldwell, 2008).
In some circumstances, certain budgeted figures within the monthly budget may vary. Instead of having specific amounts for specific expenses – like $415 for car maintenance, one could round off and budget for $500 and use whatever remains from this account to put into savings.
One can also create an emergency fund by quitting harmful habits that do not add value to one’s life like drinking and smoking. However, this is a strategy that is tricky to adopt since quitting is not as easy as it seems. However, successful quitting of smoking or drinking or both would free up a substantial amount that should be used to create an emergency fund. On average smokers may spend over $5 a day. This adds up to $150 in a month. Success in quitting smoking could result in the creation of a $150 a month emergency fund.
For individuals with serious discipline issues, one can choose to put one’s savings in a hard to liquidate the account. One could use a money market account which on maturity could be rolled over to a fixed deposits account. The idea behind the whole concept is not to get the most returns from the money, but to make it hard to access it thus building discipline over time (Dempsey 2010).
One can also invest in a piggy bank. In this strategy, one puts away all the coins and loose the change they get from payments. This strategy when pursued religiously can very easily create a substantial emergency fund without any exertions on the individual. Emptying the piggy bank once a month will creation of substantial savings in no time.
If one gets a holiday bonus as would be the case on Thanksgiving or a tax refund, one should not use this. They should instead save it in the emergency fund account. After all, this was not planned for and non-enjoyment of the windfall will not affect the quality of life expected for the particular month.
One could take their skills and use them to make extra income on the side – freelancing. This extra income should not be used to meet an individual’s monthly expenditure, but should instead be wholly invested in the emergency fund, of course after deduction any expenses incurred in the course of freelancing.
One could also give up extras that are not necessary for one’s life. One could sell off one car if they have two and work on living with one. The amount from the sale of the second car will serve to start the emergency fund. The money that would have been used to run the car will be thus used to top up the fund regularly (Burman, 2009).
Federal policies that encourage the creation of an emergency fund
The federal government has in place certain specific policies that are designed to encourage the creation of individual emergency funds and embed a saving culture in individuals. To encourage this, the government offers tax relief on all pension deductions and any life insurance payments. It also offers tax relief on payouts from matured insurance policies and pension payments. This is from a realization that the money will still be taxed when it is consumed. As such, it becomes cheaper to create an emergency fund.
The trick behind setting up an emergency fund is discipline and enjoyment (Heckman, 2006). For the emergency fund to be set up, an individual needs to be disciplined – both individual and financial. One must save regularly and consistently a specific amount of money while overcoming the temptation of accessing the money for any reason that does not qualify as an emergency. When this is achieved, the emergency fund will rapidly grow and over time can become quite substantial as even to enable the individual to achieve another goal not envisioned at the beginning without jeopardizing the emergency fund.
Similarly, external proponents have a role to play in the creation of an emergency fund by individuals. The federal government plays a significant role in adopting and enforcing policies that stimulate saving. By offering tax rebates and tax breaks on schemes designed to create one’s emergency fund, the government shows the value it puts on this venture. It could be a realization that when this particular strategy is achieved, the government can then use the money it could have used to offer individuals a soft landing in case of emergency for other ventures that offer general good to the whole population. On their part, financial experts have to offer their expertise especially concerning teaching individuals on budgeting and appropriate venture and avenues available and viable for the creation of emergency funds.
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